California, Michigan Face Doomsday Budget Scenarios

Finance directors for California and Michigan outlined dire fiscal scenarios for both states that could span far beyond the recession and into the next decade.

Short-term budget gaps have battered states as revenue plummeted during the recession. Aided by about $250 billion in funds from the stimulus package (which is being distributed through the end of next year), states managed to close the gaps this year. But both finance directors, speaking at a Pew Center on the States event, were pessimistic about their states’ futures even beyond fiscal 2011.

“We’re facing a cliff in 2011 when stimulus dollars run out,” said Mitchell E. Bean, the director of the Michigan House Fiscal Agency. “There is not an end in sight, even in recovery.”

Filling the most recent holes led states, notably California, to consider drastic options. As of July 2009, California’s budget shortfall was 49.3% of its general funds.

“I looked as hard as I could at how states could declare bankruptcy,” said Michael C. Genest, the director of the California Department of Finance who is stepping down at the end of the year. “I literally looked at the federal constitution to see if there was a way for states to return to territory status.”

There was none, so the legislature cut back sharply on education and health care to fill the gap. Mr. Genest already predicts the 2011 shortfall will outpace the projected $7 billion gap. It’s a smaller deficit than this year, but the choices will be more difficult.

“All the options have been taken away or used up,” Mr. Genest said. And with rising costs there’s no end in sight for the state’s budget woes. Mr. Genest estimated that, eventually, 40% of the state’s budget would go to the state Medicaid program, 40% to education, 10% to debt service and 6% to retiree medical services and pension — leaving little left for anything else.

Mr. Bean described a similarly depressing scenario for Michigan, which could end the recession with 25% fewer jobs than in June 2000 and a total of 1 million job losses. He noted that strict term limits often lead to political gridlock that prevents large scale reforms, such as overhauling the tax code so it is broad based with lower tax rates. In the meantime, a $2.8 billion budget gap last year led the state to make its own set of cuts and Mr. Bean said lawmakers will likely have to trim the budget at least 12.5% this year.

“Citizens don’t quite understand yet the implications of some of the cuts that we’ve made,” Mr. Bean said. “A lot of it has fallen on local governments. I am very concerned that we’re going to have a lot of insolvencies in local governments.”

Additional stimulus money wouldn’t fix the long-term problems, the two men agreed. “Unfortunately I think we’re going to have to hit the wall before we have any real reform,” Mr. Bean said, which means more localities filing for bankruptcy and maybe even some schools.

But don’t expect the states to turn down any extra funds. “I think if you ask a heroin addict if he wants some free heroin he’s always going to say yes,” Mr. Genest said.